The regulatory programs that exist today are the product of many different
forces, often operating independently of one another, but with the support
-- over many decades -- of both major political parties in both the Legislative
and Executive branches.

The
History of Major Regulatory Programs

The oldest Federal regulatory agency still in existence is the Office
of the Comptroller of the Currency, established in 1863 to charter and
regulate national banks. However, Federal regulation is usually dated
from the creation in the late 19th century of the Interstate Commerce
Commission (ICC), which was charged with protecting the public against
excessive and discriminatory railroad rates. The regulation was economic
in nature, setting rates and regulating the provision of railroad services.
Having achieved some success, this administrative model of an independent,
bipartisan commission, reaching decisions through an adjudicatory approach,
was used for the Federal Trade Commission (FTC) (1914), the Water Power
Commission (1920) (later the Federal Power Commission), and the Federal
Radio Commission (1927) (later the Federal Communications Commission).
In addition, during the early 20th century, Congress created several
other agencies to regulate commercial and financial systems -- including
the Federal Reserve Board (1913), the Tariff Commission (1916), the Packers
and Stockyards Administration (1916), and the Commodities Exchange Authority
(1922) -- and to ensure the purity of certain foods and drugs, the Food
and Drug Administration (1931).

Federal
regulation began in earnest in the 1930s with the implementation of
wide-ranging New Deal programs. Some of the New Deal economic regulatory
programs were implemented by the Federal Home Loan Bank Board (1932),
the Federal Deposit Insurance Corporation (FDIC) (1933), the Commodity
Credit Corporation (1933), the Farm Credit Administration (1933), the
Securities and Exchange Commission (SEC) (1934), and the National Labor
Relations Board (1935). In addition, the jurisdiction of both the Federal
Communications Commission (FCC) and the Interstate Commerce Commission
were expanded to regulate other forms of communications (e.g., telephone
and telegraph) and other forms of transport (e.g., trucking). In 1938,
the role of the Food and Drug Administration (FDA) was expanded to
include prevention of harm to consumers in addition to corrective action.
The New Deal also called for the establishment of an agency to enforce
the Fair Labor Standards Act of 1938 in the Department of Labor, which
is now called the Employment Standards Administration.

A
second burst of regulation began in the late 1960s with the enactment
of comprehensive, detailed legislation intended to protect the consumer,
improve environmental quality, enhance work place safety, and assure
adequate energy supplies. In contrast to the pattern of economic regulation
adopted before and during the New Deal, the new social regulatory programs
tended to cross many sectors of the economy (rather than individual
industries) and affect industrial processes, product designs, and by-products
(rather than entry, investment, and pricing decisions).

The
consumer protection movement of that era led to creation in the then
newly formed Department of Transportation (DOT) of several agencies
designed to improve transportation safety. They included the Federal
Highway Administration (1966), which sets highway and heavy truck safety
standards; the Federal Railroad Administration (1966), which sets rail
safety standards; and the National Highway Traffic Safety Administration
(1970), which sets safety standards for automobiles and light trucks.
Regulations were also authorized pursuant to the Truth in Lending Act,
the Equal Credit Opportunity Act, the Consumer Leasing Act, and the
Fair Debt Collection Practices Act. The National Credit Union Administration
(1970) and the Consumer Product Safety Commission (1972) were also
created to protect consumer interests.

In
1970, the Environmental Protection Agency (EPA) was created to consolidate
and expand environmental programs. Its regulatory authority was expanded
through the Clean Air Act (1970), the Clean Water Act (1972), the Safe
Drinking Water Act (1974), the Toxic Substances Control Act (1976),
and the Resource Conservation and Recovery Act (1976). This effort
to improve environmental protection also led to the creation of the
Materials Transportation Board (1975) (now part of the Research and
Special Programs Administration in the DOT) and the Office of Surface
Mining Reclamation and Enforcement (1977) in the Department of the
Interior (DOI).

The
Occupational Safety and Health Administration (1970) was established
in the Department of Labor (DOL) to enhance work place safety. Major
mine safety and health legislation had been passed in 1969, following
prior statutes reaching back to 1910. Enforcement responsibility now
lies with the Mine Safety and Health Administration, also in the DOL.
The Pension Benefit Guaranty Corporation and the Pension and Welfare
Administration were established in 1974 to administer and regulate
pension plan insurance systems.

Also
in the 1970s, the Federal Government attempted to address the problems
of the dwindling supply and the rising costs of energy. In 1973, the
Federal Energy Administration (FEA) was directed to manage short-term
fuel shortage. Less than a year later, the Atomic Energy Commission
was divided into the Energy Research and Development Administration
(ERDA) and an independent Nuclear Regulatory Commission (NRC). In 1977,
the FEA, ERDA, the Federal Power Commission, and a number of other
energy program responsibilities were merged into the Department of
Energy (DOE) and the independent Federal Energy Regulatory Commission
(FERC).

Another
significant regulatory agency, the Department of Agriculture (USDA)
(1862), has grown over time so that it now regulates the price, production,
import, and export of agricultural crops; the safety of meat, poultry,
and certain other food products; a wide variety of other agricultural
and farm-related activities; and broad-reaching welfare programs. Agriculture
regulatory authorities have changed over time, but now include the
U.S. Forest Service (1905), the Natural Resources Conservation Service
(1935), the Farm Service Agency (1961), the Food and Consumer Service
(1969), the Agricultural Marketing Service (1972), the Federal Grain
Inspection Service (1976), the Animal and Plant Health Inspection Service
(1977), the Foreign Agricultural Service (1974), the Food Safety and
Inspection Service (1981), and the Rural Development Administration
(1990).

In
addition to the regulatory agencies listed above, most Departments
and agencies also issue regulations that affect the public in a variety
of ways such as:

eligibility
standards and documentation requirements for government benefit
programs, i.e., USDA's Food and Nutrition Service, Health and
Human Services's (HHS) Health Care Financing Administration,
Housing and Urban Development's (HUD) Federal Housing Administration,
DOL's Employment and Training Administration, and DOI's Bureau
of Indian Affairs as well as Veterans Affairs, Education, the
Department of Defense, and the Social Security Administration;

use
and leasing requirements for Federal lands and resources, i.e.,
USDA's Forest Service and DOI's Bureau of Land Management and
National Park Service; and

The consequence
of the long history of regulatory activities is that Federal regulations
now affect virtually all individuals, businesses, State, local, and tribal
governments, and other organizations in virtually every aspect of their
lives or operations. It bears emphasis that regulations themselves are
authorized by and derived from law. No regulation is valid unless the
Department or agency is authorized by Congress to take the action in
question. In virtually all instances, regulations either interpret or
implement statutes enacted by Congress. Some regulations are based on
old statutes; others on relatively new ones. Some regulations are critically
important (such as the safety criteria for airlines or nuclear power
plants); some are relatively trivial (such as setting the times that
a draw bridge may be raised or lowered). But each has the force and effect
of law and each must be taken seriously.

The
Nature of Regulation

It is conventional wisdom that competition in the marketplace is
the most effective regulator of economic activity. Why then is there
so much regulation? The answer is that markets are not always perfect
and when they are not, society's resources may be imperfectly or
inefficiently used. The advantage of regulation is that it can improve
resource allocation or help obtain other societal benefits. For example,
consider the following situations:

Certain
markets may not be sufficiently competitive, thus potentially
subjecting consumers to the harmful exercise of market power
(such as higher prices or artificially limited supplies). Regulation
can be used to protect consumers by regulating prices charged
by natural monopolies or preventing firms from restricting competition
through mergers, collusion or creating entry barriers.

In
an unregulated market, firms and individuals may impose costs
on others -- including future generations -- that are not reflected
in the prices of the products they buy and sell. They may pollute
streams, cause health hazards, endanger the safety of their workers
or customers, or subject consumers or the broader economy to
undue risks. Regulation can be used to reduce these harmful effects
by prohibiting certain activities or imposing the societal costs
of the activity in question on those causing the harm. One goal
of regulation is to induce private parties to act as they would
if they had to bear the full costs that they impose on others.

Similarly,
in an unregulated market, firms and individuals may not have
incentives to provide individuals with accurate or sufficient
information needed to make intelligent choices. Firms may mislead
consumers or take advantage of consumer ignorance to market unsafe
or risky products. Regulation may be needed to require disclosure
of information, such as the possible side effects of a drug,
the contents of a food or packaged good, the energy efficiency
of an appliance, or the full cost of a home mortgage.

Even
when consumers have full information, the Government may wish
to protect individuals, especially children, from their own actions.
Regulation may thus be used to restrict certain unacceptable
or harmful practices such as substance abuse.

Regulation
can be an important -- indeed necessary -- corollary of some
other government policy. For example, federal deposit insurance
without supervision of those benefitting from it, could -- indeed
-- has encourag ed firms to take undue risks, leading to significant
costs to taxpayers and the economy. Similarly, government benefits
without eligibility determinations or documentation regulations
could run the risk of fraud and abuse.

Regulation
can also be beneficial in achieving goals that reflect our national
values, such as equal opportunity and universal education, or
a respect for individual privacy.

There
are also many potential disadvantages of regulating -- to the Government,
to those regulated, and to society at large -- that can give rise to
significant costs.

The
direct costs of administering, enforcing, and complying with
regulations may be substantial. Some of these costs may be borne
by the Government, while others are paid for by firms and individuals,
eventually being reflected in the form of higher prices, lower
wages, and foregone investment, research, and output.

There
are also disadvantages of regulation that are difficult to measure,
such as adverse effects on flexibility and innovation, which
may impair productivity and competitiveness in the global marketplace,
and counterproductive private incentives, which may distort investment
or reduce needed supporting activities.

In
short, regulations (like other instruments of government policy) have
enormous potential for both good and harm. Well-chosen and carefully
crafted regulations can protect consumers from dangerous products and
ensure they have information to make informed choices. Such regulations
can limit pollution, increase worker safety, discourage unfair business
practices, and contribute in many other ways to a safer, healthier,
more productive, and more equitable society. Excessive or poorly designed
regulations, by contrast, can cause confusion and delay, give rise
to unreasonable compliance costs in the form of capital investments,
labor and on-going paperwork, retard innovation, reduce productivity,
and accidentally distort private incentives.

The
only way we know to distinguish between the regulations that do good
and those that cause harm is through careful assessment and evaluation
of their benefits and costs. Such analysis can also often be used to
redesign harmful regulations so they produce more good than harm and
redesign good regulations so they produce even more net benefits. The
next section describes how regulatory analysis has evolved to do just
that.

2. Development
of the U.S. Regulatory Analysis Program

As discussed above, the late 1960's and early 1970's marked
a period in U.S. history of major expansion of health,
safety and environmental regulation. Numerous new government
agencies were set up to protect the American workplace,
the environment, highway travelers, and consumers. As with
almost every political development, the significant growth
in the amount and kinds of regulation created a counter
political development that ultimately produced a companion
program to evaluate the regulatory system.

The
Nixon and Ford Review Programs

The Nixon Administration established in 1971 a little known
review group in the White House called the "Quality of Life Review" program.
The program focused solely on environmental regulations to minimize burdens
on business. These reviews did not utilize analysis of the benefits and
costs to society. The controversy that resulted from the program began
a debate about both Presidential review of regulations and the use of
benefit-cost analysis that would continue for two decades and to some
extent continues today.

Soon
after Gerald Ford became President in 1974, he held an economic summit
that included top industry leaders and economists to seek solutions
to the stagflation and slow growth that the nation was then facing.
Out of that summit came proposals to establish a new government agency
in the Executive Office of the President, called the Council on Wage
and Price Stability (CWPS), to monitor the inflationary actions of
both the government and private sectors of the economy. It also led
President Ford to issue Executive Order 11821, requiring government
agencies to prepare inflation impact statements before they issued
costly new regulations. The innovative aspect of the Ford program was
the creation of a specific White House agency to review the inflationary
actions, mainly regulations, of other government agencies. CWPS was
staffed primarily by economists drawn from academia and had little
authority beyond the influence of public criticism.

The
economists at CWPS quickly concluded that a regulation would not be
truly inflationary unless its costs to society exceeded the benefits
it produced. Thus the economists turned the inflation impact statement
into a benefit-cost analysis. This requirement, that agencies do an
analysis of the benefits and costs of their "major" proposed
regulations -- generally defined as having an annual impact on the
economy of over $100 million -- was adopted in modified form by each
of the four next Presidents.

The
Administrative Procedure Act requires agencies to give the public and
interested parties a chance to comment on proposed regulations before
they are adopted in final form. The agency issuing the regulation must
respond to the comments and demonstrate that what it is intending to
do is within its scope of authority and is not "arbitrary or capricious." CWPS
used this formal comment process to file its critiques of the agencies'
economic analyses of the benefits and costs of proposed regulations.
CWPS would also issue a press release summarizing its filing in non-technical
terms. The CWPS analyses attracted considerable publicity. But while
this system was effective in preventing some unsupportable regulations
from becoming law, it had little success in preventing the issuance
of poorly thought out regulations that had strong interest group support.

Nevertheless,
one of the legacies of this approach was that it slowly built an economic
case against poorly conceived regulations, raising interest particularly
among academics and students who began to use the publicly available
analyses in their textbooks and courses. When benefit-cost analysis
was first introduced, it was not welcomed by the political establishment,
especially the lawyers and other non-economists who comprised many
agencies and congressional staffs. But over time, as these analyses
became standard fare in textbooks, the value and legitimacy of benefit-cost
analysis became evident, and it slowly gained acceptance among the
public.

The
Carter Review Program

After President Carter came to office in 1977, the regulating
agencies argued that the Executive Office of the President
should not have a role in reviewing their regulations.
On the other hand, the President's chief economic advisers
argued that a centralized review program based on careful
economic analysis was necessary to assure that regulatory burdens on
the economy were properly considered and that the regulations that were
issued were cost effective. Rapidly escalating inflation in 1978 convinced
President Carter of the need to act. In March of 1978, he issued Executive
Order 12044, "Improving Government Regulations." It established
general principles for agencies to follow when regulating and required
regulatory analysis to be done for rules that "may have major economic
consequences for the general economy, for individual industries, geographical
regions or levels of government."

President
Carter also set up a new group, called the Regulatory Analysis Review
Group (RARG), with instructions to review up to ten of the most important
regulations each year.

The
RARG was chaired by the Council of Economic Advisors (CEA) and was
composed of representatives of OMB and the economic and regulatory
agencies. It relied on the staff of CWPS and the CEA to develop evaluations
of agency regulations and the associated economic analyses and to place
these analyses in the public record of the agency proposing to issue
the regulation. The analyses were reviewed by the RARG members and
reflected the views of the member agencies, including the agency that
proposed the regulation.

In
this way, the Carter Administration helped to institutionalize both
regulatory review by the Executive Office of the President and the
utility of benefit-cost analysis for regulatory decision makers. Also,
in an important legal ruling, the U.S. Court of Appeals for the District
of Columbia in Sierra Club v. Costle (657 F. 2d 298 (1981))
found that a part of the President's administrative oversight responsibilities
was to review regulations issued by his subordinates.

The
Reagan/Bush Review Program

During the Presidential campaign of 1980, the issue was
not whether to continue a regulatory review oversight program,
but whether to strengthen it. President Reagan had made
regulatory relief one of his four pillars for economic
growth -- in addition to reducing government spending,
tax cuts, and steady monetary growth. He specifically used
the term "regulatory
relief" rather than "regulatory reform"
to emphasize his desire to cut back regulations, not just make them more
cost effective. One of his first acts as President was to issue Executive
Order 12291, "Federal Regulation" (February 17, 1981).

The
Reagan regulatory oversight program differed from the Carter Program
in a number of important respects. First, it required that agencies
not only prepare cost-benefit analyses for major rules, but also that
they issue only regulations that maximize net benefits (social benefits
minus social costs). Second, OMB, and within OMB the Office of Information
and Regulatory Affairs (OIRA), replaced CWPS as the agency responsible
for centralized review. Third, agencies were required to send their
proposed regulations and cost-benefit analyses in draft form to OMB
for review before they were issued. Fourth, it required agencies to
review their existing regulations to see which ones could be withdrawn
or scaled back. Finally, President Reagan created The Task Force on
Regulatory Relief, chaired by then-Vice President Bush, to oversee
the process and serve as an appeal mechanism if the agencies disagreed
with OMB's recommendations. Together these steps established a more
formal and comprehensive centralized regulatory oversight program.

In
1985, President Reagan issued Executive Order 12498, "Regulatory
Planning Process," that further strengthened OMB's oversight role
by extending it earlier into the regulatory development process. The
Order required that agencies annually send OMB a detailed plan on all
the significant rules that they had under development. OMB coordinated
the plans with other interested agencies and could recommend modifications.
It also compiled these detailed descriptions of the agencies' most
important rules -- usually about 500 -- in one large volume called
the Regulatory Program of the U.S. Government.

The
Bush Administration continued the regulatory review program of the
Reagan Presidency. Nonetheless, the pace of new health, safety, and
environmental regulations that had begun to increase at the end of
the Reagan Administration continued during the first two years of the
Bush Administration. In 1990, President Bush responded to expressions
of concern about increasing regulatory burdens by returning to the
approach used by the Reagan Task Force on Regulatory Relief. Vice President
Quayle was placed in charge of a task force -- now called the Competitiveness
Council -- whose mission was to provide regulatory relief.

The
Clinton Review Program

On September 30, 1993, President Clinton issued Executive
Order 12866, "Regulatory
Planning and Review." The Order reaffirmed the legitimacy of centralized
review but reestablished the primacy of the agencies in regulatory decision
making. It retained the requirement for analysis of benefits and costs,
quantified to the maximum extent possible, and the general principle
that the benefits of intended regulations should justify the costs. In
addition, while continuing the basic framework of regulatory review established
in 1981, it made several changes in response to criticisms that had been
voiced against the Reagan/Bush programs.

One
of the changes was to focus OMB's resources on the most significant
rules, allowing agencies to issue less important regulations without
OMB review. OMB had been reviewing about 2,200 regulations per year
with a staff of less than 40 professionals. This change enabled OMB
to add greater value to its review by focusing on the most important
rules.

A
second change was the establishment of a 90-day period for OMB review
of proposed rules. Executive Order 12291 contained no strict limit
on the length of review, and some reviews had dragged on for several
years before resolution. The Clinton Executive Order also set up a
mechanism for a timely resolution of any disputes between OMB and agency
heads.

A
third change was to increase the openness and accountability of the
review process. All documents exchanged between OIRA and the agency
during the review are made available to the public at the conclusion
of the rulemaking. The Executive Order also requires that records be
kept of any meetings with people outside of the Executive branch on
regulations under review by OMB, that agency representatives be invited
to attend the meetings, and that all written communications be placed
in the public docket and given to the agency.

OMB
has produced three reports on its implementation of this Executive
Order. On May 1, 1994, OMB published a six month assessment of the
Executive Order that the President had requested when he issued the
Order (Report to the President On Executive Order No. 12866,
1994). The report concluded that many initial improvements in the regulatory
review system had been made, but that in some areas it was taking longer
to show results than expected. Among other things, the report documented
that the new Executive Order was resulting in increased selectivity.
The 578 rules reviewed by OMB over the six-month period was about one
half the rate of review under the previous Executive Order. Freeing
up limited staff resources to concentrate on the more significant rules
resulted in a higher percentage of changes to the rules reviewed. Second,
the new time limits for OMB review were for the most part being met.
Of the 578 reviews completed in the first six months of the Executive
Order, only three had gone beyond 90 days and those delays were requested
by the agencies. Third, the report concluded that the new requirements
for openness and accountability were being met. During the six-month
period, 36 meetings were held with outsiders about specific rules under
review. These meetings were disclosed to the public and agency representatives
were always invited.

In
October 1994, OIRA produced a second report entitled, The First
Year of Executive Order No. 12866, that basically confirmed the
findings of the first report. The number of significant rules that
OIRA was reviewing fell to a rate of about 900 per year, 60 percent
lower than the 2200 per year average reviewed under the previous Executive
Order, and the number of rules that were changed continued to increase.
About 15 percent of the rules were "economically significant"--
meaning in general that the regulation was expected to have an effect
on the economy of more that $100 million per year. The 90-day review
period was generally observed, and there were about 70 meetings during
the first year, to which agency representatives were invited. The report
concluded that the new openness and transparency policy had served
to defuse, if not eliminate, the criticism of OIRA's regulatory impact
analysis and review program.

The
third report, More Benefits Fewer Burdens: Creating a Regulatory
System that Works for the American People, was issued in December
1996. The report provided a series of examples of how the agencies
and OMB had worked together to produce regulations that adhered to
the principles of Executive Order 12866. The examples were organized
around six broad themes, several of which emphasize economic analysis
and efficiency:

properly
identifying problems and risks to be addressed, and tailoring
the regulatory approach narrowly to address them;

developing
alternative approaches to traditional command-and-control regulation,
such as using performance standards (telling people what goals
to meet, not how to meet them), relying on market incentives,
or issuing nonbinding guidance in lieu of rules;

developing
rules that, according to sound analysis, are cost-effective and
have benefits that justify their cost;

consulting
with those affected by the regulation, especially State, local,
and tribal governments;

ensuring
that agency rules are well coordinated with rules or policies
of other agencies; and

streamlining,
simplifying, and reducing burden of Federal regulation.

The
report included examples of incremental improvements in the regulatory
systems across the government. Although few major eliminations or reforms
of regulatory programs were listed, the sum of the improvements indicated
that significant benefits were attained with lower costs. A key recommendation
of this report was the continued use by the agencies, and vigorous
promotion by OMB, of the principles of the Executive Order.

An
appendix to More Benefits Fewer Burdens contained information
on the costs of regulations issued between 1987 and 1996, which we
use below to estimate the aggregate costs of regulation. Another appendix
included a discussion of regulatory reform legislation that President
Clinton had supported and was passed by Congress during the three-year
period, including three statutes that require agencies to follow certain
procedures and/or consider various economic impacts before taking regulatory
action: the Unfunded Mandates Reform Act of 1995, the Paperwork Reduction
Act of 1995, and the Small Business Regulatory Enforcement Fairness
Act of 1996.

3. Basic
Principles for Assessing Benefits and Costs

In order to help agencies prepare the economic analyses
required by Executive Order 12866 or the various statutes
enacted by the Congress in the last few years, OMB developed,
through an interagency process, a "Best
Practices" document that was issued on January 11, 1996. BestPractices sets
the standard for high quality economic analysis (EA) of regulation --
whether in the form of a prospective regulatory impact analysis of a
proposed regulation, or in the form of a retrospective evaluation of
a regulatory program. The principles that are described in detail in Best
Practices aresummarized herebecause they can
serve as an introduction to how we have evaluated the studies on the
costs and benefits of regulation discussed in the following chapters.
We discuss those principles in Best Practices that are general
in nature, then those that pertain to benefits, and then those that pertain
to costs.

General
Principles

Costs and benefits must be measured relative to a baseline. Best
Practices states that "the baseline should be the best assessment
of the way the world would look absent the proposed regulation."
Typically, the baseline should start with the world before the action
taken, be consistent with other pending government actions, and applied
equally to benefits and costs. In some instances where the likelihood
of government actions are uncertain, analysis with multiple baselines
is appropriate.

Costs
and benefits should be presented in a way to maximize their consistency
or comparability. Costs and benefits can be monetized, quantified but
not monetized, or presented in qualitative terms. A monetized estimate
is one that either occurs naturally in dollars (e.g., increased costs
by a business to purchase equipment needed to comply with a regulation)
or has been converted into dollars using some specified methodology
(e.g., the number of avoided health effects multiplied by individuals'
estimated willingness-to-pay to avoid them). A quantitative estimate
is one which is expressed in metric units other than dollars (e.g.,
tons of pollution controlled, number of endangered species protected
from extinction). Finally, a qualitative estimate is one which
is expressed in ordinal or nominal units or is purely descriptive.
Presentation of monetized benefits and costs is preferred where acceptable
estimates are possible. However, monetization of some of the effects
of regulations is often difficult, if not impossible, and even the
quantification of some effects may not be easy. As discussed below,
aggregating costs and benefits is particularly difficult, if not impossible,
where they are not presented in consistent or comparable units.

An
economic analysis cannot reach a conclusion about whether net benefits
are maximized -- the key economic goal for good regulation -- without
consideration of a broad range of alternative regulatory options. To
help decision-makers understand the full effects of alternative actions,
the analysis should present available physical or other quantitative
measures of the effects of the alternative actions where it is not
possible to present monetized benefits and costs, and also present
qualitative information to characterize effects that cannot be quantified.
Information should include the magnitude, timing, and likelihood of
impacts, plus other relevant dimensions (e.g., irreversibility and
uniqueness). Where benefit or cost estimates are heavily dependent
on certain assumptions, it is essential to make those assumptions explicit,
and where alternative assumptions are plausible, to carry out sensitivity
analyses based on the alternative assumptions.

The
large uncertainties implicit in many estimates of risks to public health,
safety or the environment make treatment of risk and uncertainty especially
important. In general, the analysis should fully describe the range
of risk reductions, including an identification of the central tendency
in the distribution; risk estimates should not present either the upper-bound
or the lower-bound estimate alone.

Those
who bear the costs of a regulation and those who enjoy its benefits
often are not the same people. The term "distributional effects"
refers to the distribution of the net effects of a regulatory alternative
across the population and economy, divided in various ways (e.g., income
groups, race, sex, industrial sector). Where distributive effects are
thought to be important, the effects of various regulatory alternatives
should be described quantitatively to the extent possible, including
their magnitude, likelihood, and incidence of effects on particular groups.
There are no generally accepted principles for determining when one distribution
of net benefits is more equitable than another. Thus, the analysis should
be careful to describe distributional effects without judging their fairness.

Benefits

The analysis should state the beneficial effects of the
proposed regulatory change and its principal alternatives.
In each case, there should be an explanation of the mechanism
by which the proposed action is expected to yield the
anticipated benefits. As noted above, an attempt should
be made to quantify all potential real benefits to society
in monetary terms to the maximum extent possible, by
type and time period. Any benefits that cannot be monetized,
such as an increase in the rate of introducing more productive
new technology or a decrease in the risk of extinction
of endangered species, should also be presented and explained.

The
concept of "opportunity cost" is the appropriate construct
for valuing both benefits and costs. The principle of "willingness-to-pay" captures
the notion of opportunity cost by providing an aggregate measure of
what individuals are willing to forgo to enjoy a particular benefit.
Market transactions provide the richest data base for estimating benefits
based on willingness-to-pay, as long as the goods and services affected
by a potential regulation are traded in markets.

Where
market transactions are difficult to monitor or markets do not exist,
analysts should use appropriate proxies that simulate willingness-to-pay
based on market exchange. A variety of methods have been developed
for estimating indirectly traded benefits. Generally, these methods
apply statistical techniques to distill from observable market transactions
the portion of willingness-to-pay that can be attributed to the benefit
in question. Contingent-valuation methods have become increasingly
common for estimating indirectly traded benefits, but the reliance
of these methods on hypothetical scenarios and the complexities of
the goods being valued by this technique raise issues about its validity
and reliability in estimating willingness-to-pay compared to methods
based on (indirect) revealed preferences.

Health
and safety benefits are a major category of benefits that are indirectly
traded in the market. The willingness-to-pay approach is conceptually
superior, but measurement difficulties may cause agencies to prefer
valuations of reductions in risks of nonfatal illness or injury based
on the expected direct costs avoided by such risk reductions. The primary
components of the direct-cost approach are medical and other costs
of offsetting illness or injury; costs for averting illness or injury
(e.g., expenses for goods such as bottled water or job safety equipment
that would not be incurred in the absence of the health or safety risk);
and the value of lost production.

Values
of fatality risk reduction often figure prominently in assessments
of government action. Reductions in fatality risks as a result of government
action are best monetized according to the willingness-to-pay approach
for small reductions in mortality risk, usually presented in terms
of the value of a "statistical life" or of "statistical
life-years" extended.

Another
type of benefit can be characterized as "losses avoided." When
our banking system and capital markets systems work well, providing
capital and credit to the economy, it is easy to forget that effective
supervision and regulation is needed to prevent disasters like the
thrift crisis of the 1980s.

It
is important to keep in mind the larger objective of consistency --
subject to statutory limitations -- in the estimates of benefits applied
across regulations and agencies for comparable risks. Failure to maintain
such consistency prevents achievement of the most risk reduction from
a given level of resources spent on risk reduction.

Costs

The preferred measure of cost is the "opportunity cost" of
the resources used or the benefits forgone as a result of the regulatory
action. Opportunity costs include, but are not limited to, private-sector
compliance costs and government administrative costs. Opportunity costs
also include losses in consumers' or producers' surpluses, discomfort
or inconvenience, and loss of time. The opportunity cost of an alternative
also incorporates the value of the benefits forgone as a consequence
of that alternative. For example, the opportunity cost of banning a product
(e.g., a drug, food additive, or hazardous chemical) is the forgone net
benefit of that product, taking into account the mitigating effects of
potential substitutes. Note that since "costs" may be viewed
as benefits foregone, the difficulties in estimating benefits described
above in principle also apply to the estimation of costs.

All
costs calculated should be incremental -- that is, they should represent
changes in costs that would occur if the regulatory option is chosen
compared to costs in the base case (ordinarily no regulation or the
existing regulation) or under a less stringent alternative. As with
benefit estimates, the calculation of costs should reflect the full
probability distribution of potential consequences.

An
important, but sometimes difficult, problem in cost estimation is to
distinguish between real costs and transfer payments. As discussed
below, transfer payments are not social costs but rather are payments
that reflect a redistribution of wealth. As Best Practices states "While
transfers should not be included in the EA's estimates of the benefits
and costs of a regulation, they may be important for describing the
distributional effects of a regulation."